The Walt Disney Company was started in 1923. The company has subsidiaries and is a diversified worldwide entertainment company. Walt Disney Company operates in five segments which include: media networks, parks and resorts, studio entertainment, consumer products and interactive media.
Studies indicate that the relative mix of debt finance versus equity finance of Walt Disney used when raising funds impacts cost of capital and is known as capital structure. Firms calculate their current cost of capital to determine their current hurdle rate for internal investment projects. Grossman & Livingstone (2009) noted that “calculating the relative weights of debt and common and preferred equity in the capital structure using balance sheets book values” (p. 152).
The capital structure of Walt Disney Company can be calculated using the most recent available balance sheet book value. In 2010, the company’s book value for long term debt was $11.522 billion and the common equity value was $32.323 billion. In the same year Disney did not have any preferred stock outstanding (Grossman & Livingstone, 2009). In 2010 the price per share of Disney common stock was &23.36 and Disney had 1.876 billion shares of common stock outstanding which when multiplied together produced a market value of equity of $43.82336 billion (Grossman & Livingstone, 2009).
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According to Grossman & Livingstone (2009), from the above information it is possible to determine Walt Disney’s capital structure as follows; Capital Structure =$11,522,000,000/$11,522,000,000 + $43,823,360,000 +$0 =0.2082 or 20.82%. Also based on the above values it can be determined that Disney’s common equity is 79.18% and the preferred equity is 0.0%.
2010 Inputs for Walt Disney’s cost of capital (%)
|
Cost of debt finance |
6.96% |
|
Weight of debt finance |
20.82 |
|
Income tax rate |
36.0 |
|
Cost of common equity |
10.375 |
|
Weight of common equity |
79.18 |
|
Cost of preferred equity |
0.0 |
|
Weight of preferred equity |
0.0 |
The cost of capital of Walt Disney can be calculated as shown below;
Weighted average cost of capital = 6.96% * 20.82% * (1-36.0%) + 10.375% * 79.18% + 0.0% *0.0% = 9.14%.
Based on the above inputs the cost of capital for Walt Disney is 9.14%. This implies that on average, it costs Disney 9.14% to raise a dollar for long term capital from external investors to fund investment projects (Grossman & Livingstone, 2009). In 2012 the capital structure and cost capital of Walt Disney has changed to 25.0% and 11.02% respectively as per the company’s report in June 2012. As the amount of debt in the capital structure increases the profitability of incurring these costs also increases.
The changes in capital structure of Walt Disney resulted from legal expanses associated with establishment of more parks, resorts and studios, disruption of operations as a result of natural disasters, and loss of potentially profitable investment opportunities in countries such as China. In the year 2011, the company’s cost of capital rose when the company tried to employ more of what appeared at the previous debt equity ratio to be the least costly source of funds that is debt. Grossman & Livingstone (2009) noted that “Disney’s capital structure has changed in the past two years as a result of its need to fund internal investments and its internal sources of funds and debt capacity” (p. 153).
In conclusion, it is important to note that since Walt Disney has heavy investment in movie equipments and land, for parks and resorts as tangible assets, it has a higher debt levels. The increase in capital structure and cost of capital in the year 2011 is attributed to the firm’s heavy investment in tangible assets. From the above analysis its should be noted that if an investment project of Disney is expected to earn a rate of return in excess of the company’s cost of capital its should be accepted. On the other hand if an investment project is expected to earn a rate of return less than the firms cost of capital it should be rejected.